America is changing while we debate the minutia of the presidential candidates’ syntax and style. No conspiracies, nothing hidden. A Tonkin Gulf resolution for our generation. The Executive branch reshapes our economy in plain sight. With just a nod from Congress (no tiresome bother with debate and voting). Not only is our economy being restructured, but powerful precedents are set which will be used again. And again.
Welcome, Instapundit readers! Please share your comments by posting below. Please make them brief (250 words max), civil, and relevant to this specific post. At the end are links to other posts in this series, esp this one describing the overall cycle.
Anger is easy. Anger at the right person, at the right time, for the right reason, is difficult.
— Aristotle, in the Nicomachean Ethics, book IV, chapter 5 (lightly paraphrased)
Press Release from the Governors of the Federal Reserve System, 16 September 2008:
The Federal Reserve Board on Tuesday, with the full support of the Treasury Department, authorized the Federal Reserve Bank of New York to lend up to $85 billion to the American International Group (AIG) under section 13(3) of the Federal Reserve Act. The secured loan has terms and conditions designed to protect the interests of the U.S. government and taxpayers.
The Board determined that, in current circumstances, a disorderly failure of AIG could add to already significant levels of financial market fragility and lead to substantially higher borrowing costs, reduced household wealth, and materially weaker economic performance.
The purpose of this liquidity facility is to assist AIG in meeting its obligations as they come due. This loan will facilitate a process under which AIG will sell certain of its businesses in an orderly manner, with the least possible disruption to the overall economy. The AIG facility has a 24-month term. Interest will accrue on the outstanding balance at a rate of three-month Libor plus 850 basis points. AIG will be permitted to draw up to $85 billion under the facility.
The interests of taxpayers are protected by key terms of the loan. The loan is collateralized by all the assets of AIG, and of its primary non-regulated subsidiaries. These assets include the stock of substantially all of the regulated subsidiaries. The loan is expected to be repaid from the proceeds of the sale of the firm’s assets. The U.S. government will receive a 79.9% equity interest in AIG and has the right to veto the payment of dividends to common and preferred shareholders.
See the Wikipedia entry for AIG for background information.
This is a takeover of AIG. The new system for America is private risk-taking by politically powerful groups, with the taxpayers stepping in when necessary to take the losses. This is not the capitalism taught in grade-school. Or in Economics 101. Or Economics 901.
What was the emergency?
- The AIG holding company is insolvent, or nearly so (otherwise it could have found buyers, investors, or lenders).
- The insurance subsidiaries are probably fine, insulated by design from the holding company. (If not, then some State insurance commissioners should be fired then whipped)
- The credit default swaps in which AIG was a player are a zero-sum game. Some losers, some winners, net zero. Bankruptcy courts exist to sort out these claims.
- The creditors of the AIG holding company would get whatever; the losses would not have crippled or even damaged a $13 trillion/year GDP nation.
- The stockholders would have been wiped out, a salutary lesson in risk management for everyone.
The relevant analogy here is the Tonkin Gulf resolution. Pushed through in desperate hurry in 1964 as a response to a fake crisis, its consequences echo down history to this day.
Text of Section 13: Powers of Federal Reserve Banks
3. Discounts for Individuals, Partnerships, and Corporations
In unusual and exigent circumstances, the Board of Governors of the Federal Reserve System, by the affirmative vote of not less than five members, may authorize any Federal reserve bank, during such periods as the said board may determine, at rates established in accordance with the provisions of section 14, subdivision (d), of this Act, to discount for any individual, partnership, or corporation, notes, drafts, and bills of exchange when such notes, drafts, and bills of exchange are indorsed or otherwise secured to the satisfaction of the Federal Reserve bank: Provided, That before discounting any such note, draft, or bill of exchange for an individual, partnership, or corporation the Federal reserve bank shall obtain evidence that such individual, partnership, or corporation is unable to secure adequate credit accommodations from other banking institutions. All such discounts for individuals, partnerships, or corporations shall be subject to such limitations, restrictions, and regulations as the Board of Governors of the Federal Reserve System may prescribe.
In less advanced countries these changes occur at gunpoint, after the Palace is stormed by crowds yelling “For the Revolution!” In America our elites consult their attorneys, who comb through the millions of words of legislation, administrative law, regulations, and outright fantasy to find the necessary enabling text.
Historical note: In 1980 President Carter signed legislation guaranteeing $1.5 billion in loan guarantees for Chrysler (aprox $3B today). We have come a long way since then.
How fortunate that there is an election in November
The consequences of the recent government interventions — of which this is the latest, not the last — are wide and deep. Far greater than most Americans imagine, far beyond anything even hinted at in the government’s terse announcement. America is changing — right now, right before our eyes, in a way totally unconstitutional.
No need to wait. Email your congresscritters now! Then get involved in donating time and money to the candidate of your choice — and push him or her to take a stand on these issues.
Or you can wait until 2009, and see what happens. You might not like the result, but if so your passivity strips you of any right to complain about it.
Some advice from one of the great heroes of history
Telemachus, now is the time to get angry.
— Odysseus, when the time came to deal with the Suitors. From the movie The Odyssey (1997)
Updates
Here I will post links to material at other sites about this sad day for America.
- “The transformation of the USA into the USSRA (United Socialist State Republic of America) continues at full speed with the nationalization of AIG“, Nouriel Roubini (Prof economics, NYU), 16 September 2008 (free registration required)
- “Can the Government Buy an Insurance Company for Cheap?“, David Zaring, posted at the Conglomerate, 17 September 2008 — Interesting analysis of the legal basis for the nationalization of AIG.
- Chet Richards at Defense and the National Interest gives the best one-line summary of the situation: “That rosy red light isn’t the dawn.”
- Matthew Yglesias starts listing the ways a progressive President can use the power of these nationalized corporations to reshape America (that didn’t take long to surface).
For more information from the FM site
To read other articles about these things, see the FM reference page on the right side menu bar. Of esp interest these days:
- Good news about America, a collection of articles!
- about America – how can we reform it?
- the Financial crisis – what’s happening? how will this end?.
- about The End of the Post-WWII Geopolitical Regime.
This crisis has long been forecast by many, including in articles on this site. Even now that we are in the whirlwind, these provide valuable background material on its causes — and speculation about the results. Here are some of those posts.
- A brief note on the US Dollar. Is this like August 1914?, 8 November 2007 — How the current situation is as unstable financially as was Europe geopolitically in early 1914.
- The post-WWII geopolitical regime is dying. Chapter One, 21 November 2007 — Why the current geopolitical order is unstable, describing the policy choices that brought us here.
- We have been warned. Death of the post-WWII geopolitical regime, Chapter II, 28 November 2007 — A long list of the warnings we have ignored, from individual experts and major financial institutions (links included).
- Death of the post-WWII geopolitical regime, III – death by debt, 8 January 2008 – Origins of the long economic expansion from 1982 to 2006; why the down cycle will be so severe.
- Geopolitical implications of the current economic downturn, 24 January 2008, – How will this recession end? With re-balancing of the global economy, so that the US goods and services are again competitive. No more trade deficit, and we can pay out debts.
- A happy ending to the current economic recession, 12 February 2008 – The political actions which might end this downturn, and their long-term implications.
- What will America look like after this recession?, 18 March 208 — The recession might change so many things, from the distribution of wealth within the US to the ranking of global powers.
- The most important story in this week’s newspapers , 22 May 2008 — How solvent is the US government? They report the facts to us every year.
- Prof Nouriel Roubini describes “The Decline of the American Empire” ,18 August 2008
- The World’s biggest mess, 22 August 2008 — A brilliant ex pat looks at America from across the ocean.
- “The changing balance of global financial power”, by Brad Setser, 22 August 2008
- “The Coming US Consumption Bust”, by Nouriel Roubini, 6 September 2008
What a peculiar situation this would leave the world in, if true! Communist China with a liberal economy, Autocratic Russia with the economy heavily managed, Liberal Europe with multiple small national economies (& an opt-out option) and Democratic US of A with a socialist economy.
I get annoyed when people misquote Darwin saying “survival of the fittest”, he actually wrote “survival of the most apt”. Maybe one of the above will get the right mix?
IMO the major investment and insurance firms should be allowed to fail (they are the ‘experts’ afterall). We will likely see an “Enron period” as CEO’s are grilled over what happened (CEO of Leehmans is taking home $10 million before bonus).
In the UK yesterday an artist made £110 million selling contemporary art, economies are failing where the cause seems to be excess & greed, small wars seem to be burning around the globe, 20th century armies fighting 4GW enemies, States determined to devolve into every minor faction…maybe Rome is about to fall once more?
My bad,did not mean to imply the post was inaccurate. Just to make the point that if the USA ended up with a socialist economy it would turn everything on its head. Then again the economy may need an updated equivalent to FDR’s New Deal.
When one rents one accepts the right of one’s landlord to manage the financial terms of the space one occupies. In exchange the rentor is free of the obligation of substantial financial ties to the space or long term risk related to the space or so the rentor may think.
The simple fact is many Americans have made the decision to in effect become rentors over the last many years since the traditional mortgage became passe’. Millions surrendered their rights to control of their space. Who do we think owns our house when we agree to a 0% down mortgage? What comes for free except somebody elses problem? And that control was passed down the line repeatedly until ultimately it was mostly owned or passed through 2 entities called fannie and freddie. Well you know what? The government really guaranteed those loans and the government is us.
It’s us that surrendered this power to uncle Sam one loan and one vote at a time. When will Americans learn that you get one or 2 votes a year in a booth, and many votes a year out of your wallet? Emailing congressmen will not help. No matter what the form of government the more willing people are to sign over their rights to anything the more power government will have. If we want the power we must keep as much money and votes in our pockets as we legally can. If we want to be chattel just sign away!
By the way this applies to any entity including corporations. What stand would we have people take with this issue? Let all the financial institutions die? Great my house is safe because I own 60% of it but its worth next to nothing because my neighbors’ houses were owned by ?%$@*&^%()!_+!@#$$%%^&^*^***^&$%*^&*^&. No thats not a typo thats the mess of institutions that owns many of America’s houses, collectively, through reinsurance/bundling schemes, including AIG.
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Fabius Maximus replies: Do not be so quick to dismiss the degree of citizen influence on Congress (although emailing is an easy but relatively minor first step). Despair is cowardly, self-defeating, and in this case unjustified. Congress responds to elite opinion, but will respond to intense public pressure. We have power if we have the will to use it.
Yes FM we as the wealthiest nation ever have the power if we have the will to use it and once again it resides in our wallets and our work more than in our fingertips or our annual trip behind the curtains. We are after all a “capitalist” democracy. There are many other alternatives. We may be slouching hard toward some other. Individual fiscal responsibility is brave, self-empowering and in this case very justified.
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Fabius Maximus replies: It always comes back to us. What kind of people are we? A democracy can only function if its people make it work.
AIG was falling already in 2007. Credit Suisse turned the wheel in June 2007 *in secret*! UBS turned the wheel in december 2007 *in public*! AIG management was already named once together with ENRON. AIG is the fault of it’s management. Derivatives are bad, but derivative insurance looks to me positively criminal. Criminal and still legal. As a last point of resistance, entities of the size of AIG, Fanny, Freddie should have been prevented by antitrust legislation. These checks were not applied. The UBS president was dismissed. The UBS board of directors was dismissed. In the U.S. financial industry lot’s of heads must roll. In the U.S. Government ditto. I doubt, it will happen, at least not yet, so prepare for more trouble.
FM, I am not sure your item 4 is correct; what I kept reading is that AIG going down would take a lot of banks with it. I assume that is why the Fed intervened.
In the big picture this looks like the latest iteration of a controversy that goes back to the days of Jefferson and Hamilton and has a lot to do with what the proper, if any, notion of corporate ‘personhood’ should be, and the limits of ideology on both the left and right. When there is too much corruption going on between the political and business sides of the culture, the invisible hand of the marketplace doesn’t really operate because the game is rigged. The various panics, depressions, recessions, and corporate failures that have led to government intervention reveal a deeper systemic problem which previous methodologies and legal structures have failed to solve in the long term.
I recently saw the author of ‘Rogue Economics’ on TV and she posited that a potential alliance in the future would be between China which has essentially no financial or business infrastructure, and the Islamic world which has one based on the Sharia. It would be more than ironic for this to succeed, would it not? Might this be an area where clear moral strictures codified into law would actually be for the common good, as opposed to more frivolous and exciting areas like the banning of various plants and sexual preferences?
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Fabius Maximus replies: “AIG going down would take a lot of banks with it.”
So what? A lot of banks are going down anyway, and will need bailouts. “We had to do this to save the banks” has become the generic fake justification for doing things, joining “doing it to save the children.”
“China which has essentially no financial or business infrastructure”
Is this a joke?
IIRC the federal government nationalized Wells Fargo in 1918 as a wartime measure. I don’t recall the country going socialist collective over it.
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Fabius Maximus replies: Your analogy is defective, as the current circumstances are in key repects the opposite of WWI.
Government actions in WWI were taken in accord with a specific Constitutional process, during a world war.
Today’s actions were taken to circumvent a legislatively mandated judicial process (i.e., bankruptcy courts). Nor do we have a crisis like a world war to justify such actions.
See the link in the “update” to Prof Roubini’s article describing how the bankruptcy process would probably have worked just fine for AIG.
Aside from the obvious problems with this, which you address, the future danger is that companies will be more LIKELY to fail. Since there will be no downside to failure – provided the company is big enough and connected enough, the goal will be neither ‘efficiency’ nor ‘productivity’, but bigness and political conectedness. That’s a recipe for failure, and so the cycle will perpetuate itself and intensify.
While we’re discussing important tectonic shifts in our economy, let’s not forget the seventeenth amendment {1911, direct election of senators} passed so that Morgan, et. al. could wrest control of the U.S. financial system away from the states and relocate it to his shiny new Federal Reserve Bank…which was so tightly aligned with the British financial edifice that many economic historians today believe that it was to save the British banking system (and our own nascent Fed) that we entered WWI.
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Fabius Maxmius: Please stay on topic. Which is these current events and their future implications. Some history is useful, but this is too far afield.
Fab. You seem to posit this as some big precedent. The other viewpoint, which I subscribe to, is that this is just an ad hoc reaction to things spiraling out of control. The government isn’t taking anything over; it’s just rushing around putting out fires.
I actually would be happier if you were correct; but that’s not how I see things. Of course, nobody knows what is happening right now – so your guess is as good as mine. Which is my point.
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Fabius Maximus replies:
“just an ad hoc reaction to things spiraling out of control.”
I agree. And your point is? Why does the reason matter? Many historically critical decisions are made this way.
“The government isn’t taking anything over”
This is not factually correct, with respect to either the GSE’s or AIG. We can only speculate about the effects and next steps along this road, but the facts are not in dispute.
For years the WSJ editorial page has been warning about the problems at Fannie and Freddy. The political class (mostly Democrats, but Republicans are not blameless) have insisted everything was AOK. Also Democrats heavily pushed banks to make more questionable (subprime?) loans – remember all the angst about greenlining? These practices ultimately caused the subprime crisis and the failure of Fannie and Freddy. A major reason AIG is insolvent is that they held shares in these institutions which are now worthless.
This problem was very predicable. It was foreseen and many warnings were issued.
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Fabius Maximus replies: For a partial list of the guilty see “Fannie Mae and the Vast Bipartisan Conspiracy“, Jack Shafer, Slate, 16 September 2008 — “A list of villains in boldface.”
Another valuable record is “Fannie Mayhem: A History“, Wall Street Journal, 14 July 2008 (hat tip to M. Simon}
I am not an economist or financial guy. Isn’t the Federal Reserve a private bank? It has special arrangements with the US government but still a private bank. So how does the US government then get equity in AIG if the Fed loans AIG money? Is there a document memorializing this agreement that gets signed? Can I see that document? If not, why not?
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Fabius Maximus replies: The Fed is functionally an agency of the US Government. Wikpedia nicely explains this.
“The Federal Reserve System (also the Federal Reserve; informally The Fed) is the central banking system of the United States. Created in 1913 by the enactment of the Federal Reserve Act, it is a quasi-public (government entity with private components) banking system.”
A fundamental problem has always been for the masses a lack of ability or willingness to cope with complex ideas, such as reinsurance or banking with which to begin, let alone complicated derivatives thereof (no pun meant, not really). If only a few elites can even discuss it meaningfully, then political power will lie not with outraged masses, but with small moneyed cliques, represented in the U.S.A. by slick lobbyists (everywhere, actually, if you accept a broad definition of lobbyist).
There is no direct translation for the masses from a bank or insurer collapse to a lack of purchasing power now or later for little Susan’s school shoes, to put it crudely.
This is a deep problem I have contemplated for many years. I think there is a long-term answer, but that is of little help in such a crisis as exists today with huge, ponderous government fumbling with a broken financial system. I am sorry that I cannot offer a more useful insight than this small if significant set of memes.
Duncan: I agree… it isn’t socialism (or Socialism, for that matter) as much as the sleepy smoker with the keys to the house he set on fire trying every door to escape before the roof falls in…
Norm: No, it’s not “mostly Democrats…” unless you can explain…
– which political party was in control of the Congress for 12 years from 1994 to 2006?
– which political party has blocked substantive oversight from the Senate for the past decade?
– which political party has controlled the White House for the past eight years?
I grant you that Democrats as well as Republicans contributed to these problems, especially during the Clinton administration that only minimally controlled the potential downside of freewheeling markets that had been established by formal deregulation and subsequent neutering of the regulatory bodies that remained…
… but in my opinion, I would place the blame squarely at the feet of people like Phil Gramm and Alan Greenspan… the latter revealing himself here: “Greenspan Blames Bush for Subprime Credit Crunch“.
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Fabius Maximus replies: IMO there is no single person responsible for this mess, and both parties did their share over the past 25 years to create this mess. That being said, Greenspan is first in line of the guilty.
Concerned Citizen #12
Sadly, I think what would happen is either:
a) AIG, FNM, FRE (all the ones gov now owns) get better, in which case the government equity has value. except private friends of politicians would buy the good assets from government at low price just before things are obviously turning around.
b) Things really do go bad. Gov stuck with bill.
Either way, elite banks and politicians win, shareholders of aig, fnm, fre get screwed, and taxpayers take the risk.
another thing, notice how quiet Schumer, Dodd, Frank, Obama are about how this is happening? they are the ones that will be carving up the assets for their friends. Every other decision Bush makes (whether it be Haiti, or school books, Iraq, the name of his dog) Democrats immediately, unrelentlessly jump down his throat. Now, we have the biggest government intervention in markets in history (basically socialism) and just dead silence from the Democrats. Hmm?
Batondor,
No, its mostly Democrats
The impulse for reform in this areas has always come from Republicans, never Democrats The Democrats as a block along with a few liberal Republicans are the real “majority” that constantly blocks reform.
The Democratic answer is always more “oversite”, whatever that means. If only we had more boards, more lawyers, more accountants, more layers of bureaucracy passing memos around, none of of this would ever happen. Such nonsense. Why don’t you hold the Democratic stooges, like Jamie Gorelick that, you know, actually ran Fannie, accountable?
I would love to run a company where if can drove it into the ground and I could blame the SEC for not overseeing me.
I agree with you Fabius, that it comes down to the citizens. But at this point the next election is basically the same old people. To effect change in the parties it would of had to start before the primaries. And since the powers that be have really glossed over just how sever our financial problems are, the citizens voted the same old way. Now we have the usual choices. But we do get another chance in two years.
We are not seeing a failure of capitalism, but a failure in monetary management. The ability to float money, and create bubbles almost at will, created a false feeling of control. The Fed has been more afraid of deflation than inflation and that was reflected in the policies of Greenspan and Bernanke. Print more money and keep interest rates low! But once the housing bubble popped that ended. Trying to inflate the economy while a major segment is in sever deflation is just not possible. The government and the Feds don’t fear a recession but a possible depression and they would not being going to these extremes, like AIG, otherwise. They know how it looks.
“Never ascribe to malice that which is adequately explained by incompetence.”
— Napoleon Bonaparte
I haven’t checked this out entirely, but I would bet that we are not alone in these moves. I can’t think of a major economy whose government doesn’t either have a massive existing debt or hopelessly underfunded future commitments.
It’s the logical conclusion of Keynesian economics. Governments took on the role of “managing the economy” in nation after nation and all they managed to do was run up massive debts.
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Fabius Maximus replies: No, not everyone is nuts like us. Just from memory… Thatcher privatized the UK pension system. General Pinochet did the same in Chile. Australia has very low public debt and is working on funding its public pension systems.
My God. The Fed stepped in to prevent AIG from going under and potentially pulling the entire economy down in flames. What horror.
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Fabius Maximus replies: What is your point? Is the government justified in doing anything if it can be pitched in a child-like sound bite?
The use of “socialism” in this context is a red herring. Free market capitalism, the conceptual opposite of socialism, is a myth. Private enterprise has been subsidized, regulated and protected since the beginning of the 20th century at least. Any business that enjoys special tax treatment (oil and the extractive industries), tariff protection (autos, steel, agriculture), markets mainly consisting of government contracts (arms manufacturers, military and security providers), is socialized in the negative sense used in this post. Over fifty percent of the national budget now goes to the latter category. Is that not socialism already?
Socialism, propertly used, is a view of society in which the risks and the rewards of enterprise are distributed to the people. What we have in the US, and the west generally, is a weird kind of socialism for the rich, the corporations and financial elite. This is private enterprise only in the sense that the profits belong to the owners, while the risks, when necessary, are carried by the public. No one objects to this, as a rule, as long as it doesnt threaten our savings, our employment, or our purchasing power.
Instead of tarring the latest example of state intervention as socialism, why not consider who should benefit from the socialism that already exists.
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Fabius Maximus replies: Agree on all points. The title is just rhetoric (another one of the many over-the-top titles on this site; anything to build traffic and advertising revenue). And this is not socialism, except in the sense of man exploiting man (capitalism being the reverse).
On the title- Funny, a lot of raving self-described socialists I know would use this whole fiasco as an example of why capitalism needs to be replaced.
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Fabius Maximus replies: Agreed, as above.
I agree that the “naming names” is not the root of diagnosis in these matters (which is why I wrote “people like” even though I personally feel that Gramm had a particularly pernicious influence upon the generally reasonable notion that there can be too much regulation of markets… and that Greenspan was a poor substitute for Paul Vollker…); however, I must respond to Norm because Jamie Gorelick was more on the ‘good side’ of this matter, whatever her shortcomings, as shown here just before she left Fannie Mae in 2003: “Q&A with Fannie Mae’s Jamie Gorelick“, BusinessWeek, March 2002.
… and the proof is in the results (though of course a gross conjecture that correlates her departure with the sudden shift of mortgage insurance from Freddie and Fannie to less responsible institutions… only to have the banks run back to “government” when the going got tough…).
“Analyzing the Housing Crisis“, BusinessWeek , 31 January 2008.
There certainly is plenty of blame to go around, but I think the electorate is clearheaded enough to separate those who wanted to have “enough” effective regulation and those who wanted none at all.
Comment: “The government isn’t taking anything over”
FM replies: “This is not factually correct, with respect to either the GSE’s or AIG. We can only speculate about the effects and next steps along this road, but the facts are not in dispute.”
Let me put it to you this way: there’s a lot of difference between an Olympian equestrian riding a Lipizzaner, on the one hand, and W.C. Fields on top of a nag, flapping his arms and legs.
Yes, both are on top of the horse; but which is more likely to be thrown?
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Fabius Maximus replies: Interesting analogy, but I have no idea what it means in this context.
“The new system for America is private risk-taking by politically powerful groups, with the taxpayers stepping in when necessary to take the losses. This is not the capitalism taught in grade-school. Or in Economics 101. Or Economics 901.”
This statement is incorrect. The taxpayers are not at risk. The government didn’t buy AIG. The reason that you are confused is that the capitalism was taught to you by educators.
Here is what is happening, in plain English:
The Fed is a private company. It is not the government. It is an unusual private company, in that its board is chosen by the President of the United States (instead of its owners), but it is a private company nonetheless. It is authorized by Congress just as any other incorporated entity is authorized by the Congress.
Remember that key point: The Fed is a private bank. It is not the government. Think of the Fed as a holding company for the 12 regional Federal Reserve banks (since in essence, that’s what it is). The holding company (The Fed) has authorized one of its subsidiaries (a federal reserve bank situated in New York) to loan some money to a company (AIG). There’s nothing unusual about this. Private banks lend money to companies every day. That’s all that has happened here.
It’s a large loan, and it’s rare that the Fed lends money that its member banks wouldn’t (or couldn’t) lend to another company, but it’s not unprecedented, and not at all unusual for a bank to lend money to a company which requires it and puts up collateral (warrants to buy its stock.)
Once you admit to yourself that the Fed isn’t the government … that it’s just a bank … this should all start to make sense of you.
The Fed acted with the “support of the Treasury.” Hey, I support them too, but I’m not on the hook for anything, and neither is the taxpayer.
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Fabius Maximus replies: The Federal Reserve system is the central bank of the US, created by legislation, its Governors appointed by the government. It both controls the US money supply and is one of the chief regulators of the financial sector (both core government functions). It literally manufacturers money, having the full faith and credit of the United States. To call it a private bank is bizarre, not worth discussing
Also note that the Fed acted only after real private banks refused to lend the necessary funds to AIG.
Little factoid for consideration:
85,000,000,000 div. by 300,000,000 = $283.3333333 per US citizen which, in a year or two’s time, will be about a tankful of gas. A fair price to pay for preventing the trillions of leveraged crap that AIG was into bringing down hundreds more. Still might happen, but they have to try.
I agree with above comments that the word ‘socialism’ in this context is red herring. What we have here is some of the underlying flaws in the so-called ‘free-market capitalist’ system. All systems ultimately depend upon honesty and intelligence. Mercantilism let loose without firm checks and balances pretty much always leads to insane levels of usury, which is what these leveraged instruments basically boil down to. Usury in the flexible sense of trying to make lots of money out of a little without actually producing anything. That mentality – and increasingly process – is what has more and more been underpinning the US economy the past few decades.
This brings into question the underlying value system of the entire country, including all citizens.
Points of order:
Saying “the Fed is a private company” is like saying “The Vatican is a nation-state”…
Saying “Fannie Mae and Freddie Mac” are not part of government is like saying the only difference between Bank of America and the Fed is one of scale…
Saying that “Fannie Mae and Freddie Mac are mortgage insurers” is literally wrong (and yes, I said it in #22), but it was the practical reality in the managed market in mortgage-backed securities that preceded the changes that occurred 2003…
The question is both the formal role of these institutions in the economy as well as their practical impact… but only the latter is really malleable by politicians with either an axe to grind or an eyesore to hide from view…
Update: I could have found a better example than the Vatican, I suppose (with apologies to any injured Catholics).
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Another factoid: the first big bailout in my adulthood was Chrysler. That was generally considered a healthy, even creative response by all — Wall Street, Main Street and labor. Iaccoca became a national hero, and could have run for President. Taxpayer risk: about 1$billion (the loan was actually re-paid!).
There’s a lot wrong with companies like AIG (not that different from Enron, on the question of transparency), but the risk of letting it go under apparently was great enough to threaten global depression. So I believe the bailout was a good-faith effort to save the system of state-supported private enterprise, even though it may turn out to have been too late and too little.
It would be nice if the same kind of risk/reward calculus were applied to our military budget and military adventures, generally lacking any social benefit at all.
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Fabius Maximus replies: Please, some skepticism is in order here. If the government can do anything it likes by inventing reasons, our freedom will vanish like a winter’s snow. There is little basis for the belief that “risk of letting it go under apparently was great enough to threaten global depression.” Prof Roubini discusses this in the next post.
Sir, I freely admit entering a state of profound puzzlement whenever I think on questions of high finance, so I am delighted to have (virtually) met a person of such certain knowledge as yourself. Let me seize this opportunity to grow wiser by asking you a few questions.
First, if the Fed is a private bank, or consortium of such banks, how great are its assets? (I won’t be picky–an answer to the nearest million dollars will do.) Surely, however great that number, it is finite. Ergo, it is possible that even this bank could over-extend itself, and run out of money, correct?
If the answer be “yes”, then I must ask (with tremulous voice, considering that institution’s recent profligacy): if the Fed runs out of money, who can bail it out? Truly, ’tis the stuff of nightmares: the Fed has propped up the financial institutions of this indubitably munificent country to the point where it has used up all its own resources. What happens then? I am greatly unsettled by such thoughts; perhaps it is best not to think on some things.
On the other hand, if the Fed cannot run out of money, then I find your assertions of its private nature dubious. Nobody I know has limitless resources. (Perhaps I am moving in the wrong circles?) If the Fed is not mortal, then I must suspect that its money comes from somewhere else, that another, very powerful guarantor stands behind it. An organization that owns a great many printing presses, I would say.
Good post, Reynardine.
“if the Fed runs out of money, who can bail it out? ”
I believe you’ve characterised it as the backstop, analogy softball.
The genteleman you replied to makes it sound almost like a reletively routine hapenstance, which if I understood him, is mis-leading under the circumstances, coming as it is on the heels of a string of events, with even more possibly looming.
“to the point where it has used up all its own resources. What happens then?”
Exactly, a few more similarly serious hits, where similarly forced to intervein, yet another “war” or significant natural disaster, then what? It might not take too much more at this stage.
Remember, the USA and it’s finance are not in particuarly good shape all around these days, and that was last week.
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Hopefully someone better informed than I can clarify if this is wrong, but it is my impression/understanding that the Federal Reserve can literally print money to create assets. Also they issue the govt bonds, I believe, which many nations and trading partners use to hold the dollars they need for oil, business operations and so forth. But ultimately it is my impression – again perhaps false – that the Fed banks do not have to have assets per se as is the case with a private institution. I would love to read a short, pithy article about exactly what they are and how they function.
Here is a link to a booklet on the Fed’s main website: “The Federal Reserve System: Purposes & Functions” (136 pags) — Provides a detailed look at the structure, responsibilities, and operations of the Federal Reserve System. Chapters include: Overview of the Federal Reserve System, Monetary Policy and the Economy, The Implementation of Monetary Policy, The Federal Reserve in the International Sphere, Supervision and Regulation, Consumer and Community Affairs, and The Federal Reserve in the US Payments System. Includes a brief explanation of Federal Reserve regulations and a glossary of terms.
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Fabius Maximus replies: Yes to the first, no to the second. Only the US Treasury can issue bonds. Controlling the money supply, the Fed can “monitize” the debt by “printing” money and buying government bonds. The Wikipedia is fine; the Fed’s website has good explanations of its functions.
The Fed has a balance sheet, which it can expand at will by printing money. Or destroy through bad investments. Or the Treasury can give it more capital. Both mechanisms have advantages and disadvantages, and either or both might be needed before this cycle is over.
“First, if the Fed is a private bank, or consortium of such banks, how great are its assets?”
{snip — This is comment is mostly incorrect and the subject grossly off-topic. To understand the operation of the Fed, consult the Fed brochure listed in comment #32, or any basic textbook about finance or economics.}
Another interesting article on the financial mess we are in.
“Lehman and the end of the era of leverage“, By Spengler, Asia Times, 16 September 2008 — Excerpt:
“To increase economic value you must create products. You can’t increase value by pushing money from point A to Point B and back again. Leverage or margins makes it appear that you can until things go bust. We are there now. The Fed and our governments attempt to eliminate economic down turns through regulation has now failed. Many leftist will try to blame capitalism but it’s just human weakness’s, which socialism does not solve but makes worse, that have brought us to this point.
“Sometimes it is said that man cannot be trusted with the government of himself. Can he, then be trusted with the government of others? Or have we found angels in the form of kings to govern him? Let history answer this question.”
“I know of no safe depository of the ultimate powers of the society but the people themselves; and if we think them not enlightened enough to exercise their control with a wholesome discretion, the remedy is not to take it from them but to inform their discretion.”
— Thomas Jefferson, September 1820
{FM note: this replies to a comment which I have snipped as grossly off-topic, and mostly wrong. Thank you for the rebuttal to it, but debating these fringe topics burns valuable floorspace on the FM site}
I’m VERY glad the gov’t let Lehman’s Brothers go belly up. I think I’d have preferred AIG to go bankrupt, and have a court ordered clean up that looks a lot like the Fed loan-based nationalization cleanup. I certainly would prefer that the share-holders get zeroed out, and even that the officers get nothing.
AIG was too big. If any company is “too big to fail”, such a company is too big. There should be a revenue/bailout tax on such big companies, that covers such bailouts.
I would like new “windfall bonus” taxes on the bonuses of these top execs. I read that the CEOs of Fannie & Freddie got $15 mil; bah. They should get nothing. And what they got last year, and the last 7 years (including J. Gorelick), should be subject to some clawback tax on irresponsibility.
In the case of Fannie, there were certainly individual Reps calling for reform, which was blocked mostly by Dems but with some quiet Rep support.
We have power if we have the will to use it.
The essential problem is that We, The People, have chosen to consume. The Power of Credit based buying (pay later!). And it turns out that neither AIG, nor Fannie, actually has the power to make us pay it back. So, the econ meltdown is the alternative way of ‘paying back’ the borrowed money, when borrowers (by the tens of millions) fail to repay.
Capitalism DOES require enforcement of contract. Like foreclosure. Each enforcement has costs. But right now, the enforcement of so many violated contracts, has so many synergistic costs (trying to sell assets as asset prices are dropping), that … capitalism has temporarily failed.
The mess won’t end until housing prices stabilize, so that securitized products with mortgages have a more known value. The gov’t should be pushing more house buying, now — perhaps with a GI Homeowners bill ($1000/month bonus for all returning servicefolk, up to $22 000, for use in an equity downpayment on a home).
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Fabius Maximus replies: As for the “govt pushing more house buying”, this is a common misunderstanding of the problem.
It’s overbuilding, excess supply of housing units (broadly defined). Today there are 4 – 5 million vacant housing units above historical average rates (as a % all units). For example, the Census Dept’s Housing Vacancy Survey shows that 2.8% of owner-occupied units (vs. rentals) are vacant, almost 2x the historical average of 1.5%.
This surplus is driving down prices, and it is difficult to fix. Interest rates do little to solve this; nor will govt aid. At what interest rate would you buy a 2nd home in your neighborhood for your family to live in?
Demographics (net new households + migration) will absord them, eventually. Many will be destroyed (esp in regions with net out-migration). Until then they will exert downward pressure on home prices. Prices will stabilze eventually, if for no other reason than they reach a point at which investors will voluntarily accumulate inventory — vacant homes, which they will maintain until they can be sold or rented.
Recasting Tom’s proposal into something that would work: the government could buy and destroy homes. As it did with food during the Depression, in order to increase food prices (to help farmers).
Your contention #2 about the insurance subsidiaries may not necessarily be correct. If the assets backing policyholders’ claims were pledged as collateral in any of AIG’s swaps, they will be subject to counterparty claims. Your proposed punishment for state insurance commissioners would be appropriate in that case. Regulators don’t have a great track record lately anyway.
http://alfidicapitalblog.blogspot.com/2008/09/aig-truly-is-all-american-now.html
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Fabius Maximus replies: This is just another way of saying that the capital of the insurance subsidiaries might be inadequate due to investment losses. In this case, mispricing of the swaps might conceal the losses from regulators — who could otherwise force remedial action.
It is possible. These days who can tell? But until shown otherwise, I assume that the capital cushions are adequate at the subs.
I like how you “snip” people’s comments that you disagree with. I guess you’re right. We have become the Soviet Union.
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Fabius Maximus replies: The comment policy is clearly stated in the “About” page and at the end of every post. This post is not about whether the Fed is a private bank. The first post was relevant, and remains. The second did not even mention AIG, off on a tangent. I would have kept it if you had addressed any of my comments to your original comment (it being impolite to snip answers to my questions).
Also, as I noted, you appear to be just making things up. I will give just one example, as this is really a waste of time.
Q: “First, if the Fed is a private bank, or consortium of such banks, how great are its assets?”
Your answer: “That’s none of your business, since the Fed is a private bank. You should encourage your local representative to make sure he knows that and not to give it any of your tax dollars, since it is a privately held company.”
The Fed publishes its statement of financial condition in their weekly H.4.1 release. As of 10 September the total assets of the Fed system was $924,865 million.
Last, your comparison with the Soviet Union is absurd. This is not public property. It is private property, subject to the whims (however irrational) of the proprietor. There is no tax dollars at work; nor do you pay to either write or read on this site. So I see no grounds for you to complain.
In terms of the Fed Balance, another interesting factoid on the Wikipedia page:
$11 billion in Gold at 42.222 per ounce.
At today’s current price around $850 per ounce this 11 billion becomes
$221,448,533,940.
So their assets are far greater than published on that count. Thanks for correcting me on the bonds, FM. I realised after I posted. I tend to regard the Fed and the Treasury as being sister organizations. Especially since nearly all heads in both branches come from Goldman Sachs.
I wonder if we might be getting into an 1815 scenario when, after a firesale on the London Stock Market following the initial report that Wellington had lost Waterloo (which was true until Blucher came late in the day to turn the tide), one major bank ended up owning pretty much all UK shares at 20% of the value they were the day before! This bank had better intelligence and knew the battle had been won.
I am very curious to see how Goldman Sachs does with all this since their people are in charge of the Fed and the Treasury and have been, more or less, for some time.
According to the Market Watch article, and as mentioned by the finance team at Slate, the Fed’s reserves have gone from around 800 billion to around 200 billion. The Treasury is making a $40 billion auction whose proceeds will go to the Fed.
Now, I cannot tell from reading the Fed’s pages, Wiki etc. really how they value these reserves. If they use 42.22 per ounce for gold, are their securities listed in terms of book or market value? They don’t say.
But if the 800 to 200 billion shift this year is roughly accurate, that means we are getting close to the Fed running into the red which I presume is not a good thing.
Slate article which is sister to one linked by FM elsewhere:
“Where Did the Government Get $85 Billion?“, Slate, 17 September 2008 — “Was it just lying around somewhere?”
“Treasury to provide cash to Fed for liquidity moves“, Marketwatch, 17 September 2008 — “Offers $40 bln of 35-day cash management bills”
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Fabius Maximus replies: The Fed’s reserves are insignificant in size and almost irrelevant from a policy perspective. Just like FDIC’s reserves, these are accounting fictions for what are in effect departments of the US government. No more limiting than DoD’s checkbook balance limits our ability to wage war.
The US government’s foreign exchange reserves are a seperate and potentially more important issue. But that is a discussion for another day.